Banks said to draw plans for cutting back online lending risk

[NEW YORK] Some of Wall Street's biggest banks are making contingency plans to cut their exposure to online consumer loans if the market deteriorates further after the recent crisis at LendingClub Corp, people with knowledge of the reviews said.

While firms including Credit Suisse Group AG and Deutsche Bank AG haven't scaled back exposure, they're concerned about financing they provide to institutional investors that buy loans from companies like LendingClub and Prosper Marketplace Inc, the people said.

Industry lawyers estimate that banks have funded a few billion dollars of online loans for investors through these credit lines. Wall Street lenders are looking to avoid making the same mistakes they made in the subprime crisis, when they were late to limit their exposure to bad mortgage loans.

Lawyers specializing in these financings and banks' risk committees are looking at how they might reduce, renegotiate, or even cancel funding agreements with investors, the people said.

Banks want to have plans in place if they later decide to cut back, said the people, who asked not to be identified because the plans are not public.

A spokesman for LendingClub said the company is talking to new banks about their offering funding, and doesn't know of any banks that are declining to provide financing for its loans. A spokeswoman for Prosper declined to comment. Spokesmen for the banks declined to comment.

The discussions come after the surprise departure of Renaud Laplanche, founder and chief executive officer of LendingClub, two weeks ago. The company's shares have fallen by more than 35 per cent since then.

The company said it found deficiencies in its internal controls. It faces a grand jury subpoena from the US Department of Justice, and investors that provide a significant portion of its funding have paused purchases of its loans.

Banks are much more sensitive today about limiting their exposures to risky lending and cutting back on any business line that may damage their reputations than they were before the financial crisis.

For investors, that could mean that banks will cut off credit to customers even if loan performance hasn't significantly deteriorated, said Rob Allard, who previously worked on complex debt instruments at Goldman Sachs Group Inc and Deutsche Bank.

"This is noise banks want to avoid," said Mr Allard, who heads FireBreak Capital, a hedge fund that focuses on lending.

Wall Street firms are particularly concerned about the short-term funding they provide to investors to help them buy online loans that are usually packaged quickly into bonds and sold to other fund managers, the people with knowledge of the reviews said.

Known as "warehouse lines of credit," this form of financing triggered billions of dollars of losses for banks during the subprime crisis. Starting around 2007, mortgage companies that had planned to bundle their loans into bonds found that investors wouldn't buy their securities. The companies couldn't pay off the short-term financing from banks that funded their home loans.

A similar type of problem could unfold if investors stop buying online loans and the bonds backed by them, said Richard Kelly, a managing director at New Oak Capital Markets, an advisory firm in New York.

If investors can't package loans into bonds, banks may need to seize the loans, Mr Kelly said. "Borrowers typically don't have the ability to repay in cash," he said. "That is a problem for banks," which may not want to own such loans, he said.

Banks provide different kinds of credit lines to institutional investors for online loans, including warehouse lines and temporary financing for money managers that plan to hold onto the assets.

In a downturn, online lenders may find that their funding from individuals, hedge funds, and securitized markets evaporates, said JPMorgan Chase & Co chief executive officer Jamie Dimon earlier this month. Online lenders like LendingClub and Prosper and crowdfunders arranged more than US$36 billion of financing in 2015, mainly for consumers, up from US$11 billion the year before, according to a report from KPMG.

Not all lenders are cutting back. Prime Meridian Capital Management is a loan investor that with help from a bank is increasing investments in loans made mainly by Prosper and LendingClub, said Don Davis, a portfolio manager at the asset manager.

It owns about US$160 million in such loans and manages two consumer loan funds, one of which is levered with the help of Capital One Financial Corp. A spokesman for Capital One declined to comment.

Prime Meridian Capital is increasing its leverage and bets on the loans, and intends to finance about 70 per cent of its holdings in the levered fund, up from about 50 per cent, in coming months, Mr Davis said.

"As far as the quality of loans we hold in our portfolio, I see absolutely no problem with those loans, past, present or future," Mr Davis said.

Some online loans have begun showing signs of stress. In February, Moody's Investors Service said that Prosper loans that Citigroup had packaged into bonds were souring at a faster rate than the ratings firm had previously expected. Since then, Prosper has twice increased the rates it charges for riskier loans made through its platform, most recently on Tuesday.

The reverberations from LendingClub's announcement earlier this month are still being felt in the market for loans to consumers that are made online, said Patrick D Dolan, a partner at law firm Dechert representing institutional funds that buy online loans.

He hasn't yet seen any amendments to his clients' credit lines, but "they could be coming," he said. "It's still early days."

BLOOMBERG